The automotive business model has always been one of change and adaptation. We believe the looming shift from a model of independently-owned, personally-operated, internal combustion engine-powered vehicles to shared, autonomous, battery-powered electric vehicles will bring with it a plethora of implications across many industries. Addenda's Sustainable Investing team has collaborated with Portfolio Managers on the Canadian Equities team to provide a sector-by-sector primer on some of the potential effects of the vehicle revolution. We believe that the interdependence of these trends and their self-reinforcing power cannot be understated and will reverberate well beyond the auto industry. The rate at which these developments will occur, however, is much more difficult to determine, as it depends on a wide range of factors, from policy decisions by governments to the cost of lithium-ion batteries. The purpose of this report is to provide an overview of the potential impacts this shift could have on various sectors and industries within the economy.

Auto 1.0 — The Current Model

A 2016 report from Morgan Stanley claimed that "your car is arguably one of the most underutilized, polluting, time-consuming, and dangerous machines on earth"1, basing their conclusion on the following findings. Cars are in use for an average of just one hour per day, which equates to a vehicle utilization rate of about 4% on a 24-hour day. Transportation fuels account for the single largest portion of global oil demand, with light vehicles accounting for around 45% of global oil demand. Drivers spend around 400 billion hours of time operating their vehicles each year, during which time they can focus on little else. Per the World Health Organization, 1.3 million people die every year in traffic-related accidents, which equates to nearly 3,500 deaths per day.

The good news is that, in the new world of "Auto 2.0" many of these issues can be addressed with technologies that exist already or are currently being developed.

Auto 2.0 — The Future Model

There are three emerging trends occurring simultaneously that are disrupting the auto industry, any one of which would be highly disruptive in isolation. These trends are electrification, automation, and sharing, each of which reinforces the potential of the others. A shared model increases utilization by an order or magnitude, shortening the payback period for vehicle ownership, which can mitigate the relatively higher cost of electric vehicles. An autonomous vehicle is envisioned to be relatively safer than a human driver and can optimize factors such as speed and route logistics, which is a necessity of the shared vehicle system. Lastly, automating an electric vehicle is less complex than automating an internal combustion engine.

Global Oil Demand

Estimates of the speed and potential magnitude of the movement to electric vehicles continues to accelerate. In 2017, Bloomberg New Energy Finance (BNEF) published a long-term forecast of global electric vehicle adoption to 2040. They reported that the adoption of electric vehicles will occur more quickly than they had estimated just one year prior, an update that they based on the falling cost of building electric cars. They now predict that cars with a plug could account for a third of the global auto fleet by 2040 and displace about 8 million barrels a day of oil production. To put that in context, that's more than the current combined production of Iran and Iraq. Between 2015 and 2016, The Organization of Petroleum Exporting Countries (OPEC) quintupled its forecast for sales of electric vehicles2, raising its 2040 electric vehicle fleet prediction to 266 million from the 46 million it anticipated a year prior. OPEC believes that electric vehicle sale targets, if realized, could begin to dampen demand in some parts of Asia as soon as 2018.

Non-OPEC oil producers are taking increased note of the electric vehicle trend and have also been revising their forecasts: Exxon Mobil increased its 2040 estimate to 100 million from 65 million, while BP anticipates 100 million EVs on the road by 20353, a 40 percent increase in its outlook from just a year prior.

The reality is that while the electric vehicle revolution is occurring, the timing remains highly uncertain and as such oil is expected to remain a significant source of energy for the foreseeable future. While we are confident that oil demand will be impacted over time, the exact magnitude remains an unknown due to offsetting factors that at this point in time are difficult to measure. For example, while energy demand from developed countries is already being impacted negatively as electric vehicle market share expands, this is expected to be offset as many new drivers in developing countries such as China and India are likely to continue to choose gasoline and diesel based automobiles until the price of electric cars falls to a reasonable level and charging infrastructure is in place for convenient long-distance travel.

Industrial Commodities

Electric vehicles represent a rapidly growing source of demand for rechargeable batteries and their input commodities, which include copper, aluminium, lithium, nickel, manganese, and cobalt. Under BNEF's scenario of electric vehicle growth, graphite demand is expected to rise to 852,000 tons a year in 2030 from just 13,000 tons in 2015, nickel and aluminum demand will both see demand rise to about 327,000 tons a year from just 5,000 tons in 2015, and production of lithium, cobalt and manganese will each increase more than 100-fold4.

Conventional internal combustion engine cars contain about 20kg of copper, while hybrids contain about 40kg, and an average battery powered electric car requires about 80kg.5 Huw McKay, vice-president of market analysis and economics at BHP Billiton, calculates that building a fleet of 140 million electric vehicles by 2035 will require about 11 million tons of copper. After subtracting the copper that would have been used in the displaced conventional cars, that becomes 8.5 million tons of genuine new demand for copper — over a third of global copper demand today.6

Lightweight metals like aluminum are replacing steel, as they allow cars to use less power and therefore travel further. Demand for aluminum has already expanded by about 1.6 million tons, or 2.7% of global output, from 2013 to 2016.7 In response, steelmakers are now trying to use nanotechnology to make lightweight vehicle bodies and develop lighter, stronger alloys to provide alternatives to aluminum.

A lesser-known commodity linked to the electric vehicle revolution is cobalt. Cobalt is a key component of cathodes of certain types of rechargeable lithium-ion batteries. Currently, approximately 50% of demand comes from consumer electronic devices, while electric vehicle demand accounts for 15%8, a level that is expected to grow rapidly as electric vehicle manufacturing evolves. However, there are several environmental and social risks to consider with regards to the cobalt market due to the high concentration (51 %) of current global cobalt supply sourced from the Democratic Republic of Congo. This raises political, social and supply risk issues given the country's unstable political regime and extensive use of child labour. According to UNICEF, about 40,000 children work in underground cobalt mines in the DRC, most earning less than $2 for up to 24 hours of work.9

Utilities

Electric vehicles are expected to bring many opportunities and challenges for utility companies. The first is expected higher levels of electricity demand — a potential positive for both generators and transporters. One of the main problems potentially facing grid operators will be meeting additional demand, particularly at peak times. Adding a new layer of peak demand from electric vehicles could lead to greater system cost, through the need for more generation capacity, and potential investment to strengthen and expand transmission and distribution networks10.

The need for new charging point infrastructure and its maintenance will require both public and private investment which is complicated by the fact that each electric car manufacturer uses different types of connectors for charging points. The hardware to deliver electric charging will need to be standardised and grow quickly to accommodate the potential growth in this space — and some may even argue that this needs to come first in order to gain public confidence to buy electric vehicles.

We note, however, that 80% of electric vehicle charging is currently done at home or while at work11 which could present opportunities for Utilities to redirect existing infrastructure and the potential for some load management optimisation work to occur on local networks. The Utility companies could also be part of the solution associated with the required deployment and maintenance of "public" infrastructure.

Consumer Staples

Gasoline retailing will continue to evolve, as it has constantly done over the past 50 years. In its early days, it was full service gasoline retailing and car servicing owned and operated predominantly by the oil companies, which has now evolved to a self-service model with convenience stores and car washes and an ownership base quickly shifting to Consumer oriented companies. One version of the future model may include charging stations combined with higher end restaurants or shops to capitalise on the fact that customers will remain at the site for longer periods to charge their electric vehicles.

Companies such as Shell have committed to installing electric vehicle chargers at their gas stations12 and car manufacturers like Tesla have also started using gas stations as locations for its Superchargers.13 Canadian based Alimentation Couche-Tard, has emerged as a leading global gasoline retailer and is expected to be a leading player in the transformation of the retail space. It has already indicated that it is looking to Norway "as a laboratory to the future" 14 for guidance on how to adapt to the growing market share of electric cars. Given that it can take anywhere from half an hour to several hours to fully charge an electric vehicle, Couche-Tard is testing a variety of fresh food and other offerings at some of its locations in Norway in the hopes that the expanded length of time consumer will be spending at its site will allow it to redefine the customer experience and ultimately expand the transaction size realised with each visit.15

Technology and Suppliers

Technology is the backbone of the mobility revolution. From an engineering perspective, electric vehicles are easier for computers to drive and accordingly self-driving or autonomous technology will probably be developed here first. "There are a lot fewer moving pieces in an electric vehicle. There are three main components — the battery, the inverter and the electric motor," says Levi Tillemann-Dick, managing partner at Valence Strategic. "An internal combustion engine contains 2,000 tiny pieces that have to be kept lubricated and they break every once in a while." 16

Apple is reported to have invested $10 billion in an iCar17, while Google is working on an entire operating system for connected, autonomous cars. This shift towards "Silicon Valley" motors could result in divergent paths for traditional auto equipment suppliers. Morgan Stanley classifies suppliers into four groups (Exhibit 6). According to their research, high-tech suppliers that contribute content into the autonomous vehicles of the future or enable non-traditional new entrants to quickly come to market should be clear beneficiaries.18

Magna International (MGA) is an example of a Silicon Valley enabler. Through its Magna-Steyr operation in Austria, the company provides outsourced design, engineering, tooling, and complete assembly services. This is one of the few non-captive, scale operations of its kind in the world, which has the potential to become a large growth driver over time. Success within the emerging business ecosystem for connected car development will require rethinking how manufacturers, suppliers, and technology companies operate — both separately and together.

Insurance

When it comes to insurance, technology is still far ahead of regulation which leads to numerous questions such as: Who is liable for an accident by an autonomous vehicle? While the law firm Borden Ladner Gervais issued a report in August stating that, even if a car is in semi-autonomous mode, the driver remains liable it is clear that regulation and insurance policies will need to be adapted for the rapidly changing world around electric, shared, and autonomous vehicles. Volvo, Daimler, Google and other companies have already indicated that they will accept 'full liability' for driverless car crashes and like other governments, the Canadian government has set aside funds to improve motor-vehicle safety, part of which will be put towards developing new rules for self-driving cars.19

Warren Buffet said that self-driving cars could become a major threat to insurance companies when the technology hits the market20 and insurance rates are already starting to come down for owners of vehicles with semiautonomous features such as lane keep assist and adaptive cruise control.21 Exhibit 7 highlights some key forces that stand to reshape the sector, as outlined in a 2015 study for Swiss Re.22 The offset is that there will certainly be new, and potentially significant revenue stream opportunities available to innovative insurers.

Conclusion

The obvious conclusion from this discussion is that a shift to a model of shared, autonomous, and electric vehicles has implications across many sectors, and that as one issue or question is resolved, it will create many more! The challenge facing investors will be to keep up with the evolving trends and to sort out which will have lasting impacts, both positively and negatively, on their portfolios.

Our teams of Portfolio Managers in all of our asset classes work in tandem with our Sustainable Investing team to ensure that we remain at the forefront of evolving trends, and when possible, embed factors such as the ones identified in this report directly into our research and valuation. We believe this approach makes us better informed and smarter investors which in turn allows us to ultimately generate the best investment outcomes for our clients.

Addenda Capital is an investment management firm providing solutions for institutional and high net worth clients. We offer our clients expert services in a broad range of asset classes. Our mission is to add value through innovation, discipline and integrity, and to nurture genuine partnerships with our clients.